Hoping someone can tell me if my bond math is correct and whether or not I make any sense in trying to construct a bond portfolio across tax advantaged and taxable space.

Let's say I'm risk-averse and want to adhere to the following:

Annette Thau on page 408 wrote:

If you are risk-averse, for most of your bond portfolio, two-to-five-year Treasuries and five-to-ten-year munis will provide the best combination of risk and return.

But of my entire bond portfolio, I can only fit 10% in tax-advantaged accounts. Also assuming I want to hold 50% treasuries/50% munis. The munis can be placed in taxable using an ETF like MUB (iShares National AMT-Free Muni Bond ETF) which has an effective duration of 6.07 years so that criteria is easily met. Also worth noting I live in Florida so no state income tax on munis.

I'm considering different options to break up the treasuries. Here are the average effective durations of various bond ETFs:

If I want to hold 50% of my bonds as 2-5 year treasuries, which option makes the most sense?

1) Hold IEI and spread it amongst both taxable and non-taxable space. This averages our to a 4.43 year effective duration. 2) Hold TLT in non-taxable, hold SHY in taxable. This averages out to a 4.8 year effective duration - (1.80*4+16.8)/53) Hold EDV in non-taxable, hold SHV in taxable. This averages out to a 5.6 year effective duration - (0.44*4+26.4)/5

Now that's assuming I'm correct in my calculations about bond barbells. And to be sure, this is an exercise in trying to maximize my tax advantaged space.

So there's average duration as well as yield to consider. The TLT/SHY mix appears to have the same average yield to maturity as holding 100% IEI. The EDV mix loses .2%. Perhaps that is made up with greater convexity, but frankly I just barely understand that concept at the moment.

I know holding long-term bonds is generally frowned upon, but I'm wondering if in this case, a barbell really does make more sense.

(Thanks for the tip Taylor)

Last edited by K-Bogle on Thu Feb 07, 2013 2:56 pm, edited 4 times in total.

hlfo718 wrote:Have you thought about building your own ladder treasuries so you can skip paying the fees? You can buy new issues from some brokers like Fidelity and Schwab without paying a commission or spread.

I have thought of this. Probably something I should research further.

pascalwager wrote:You can use the (optimal) duration (currently 3.8 years) shown for the DFA 5-Year Global Bond Fund to weight two of the above funds to achieve this weighted duration.

So in my case with limited tax advantaged space it could make sense to use a longer duration fund in a tax advantaged account and a short duration fund in taxable? As long as my overall weighted duration falls within the desired intermediate treasury range?

Have you considered building a CD ladder with some of the funds allocated for fixed-income? I've found the PenFed one- to three-year term CDs* quite competitive with short-term corporate or treasury bond funds, and without the inherent credit- or interest-rate risk. PF's yields (currently) on those CDs are 1.25% (1 yr), 1.6% (2 yr), and 1.85% (3 yr). PF is an "all access" CU (easy to join) and NCUA-insured. The rates pretty much plateau at 3-yrs (you can go out longer, but there's not much premium for doing so). The CDs are available as IRA CDs as well. The custodian-to-custodian transfer is fairly simple (I've done it twice with PF).